MetaStock U explores Candlestick Patterns

Candlestick Patterns Following Patterns Produce Profitable Consistency - January 31, 2012
By: Stephen Bigalow

Candlestick analysis is the epitome of technical analysis. If the definition of technical analysis is to recognize price patterns, candlestick signals and patterns exemplify that process. The basis of candlestick analysis is the visual identification of investor sentiment put into a graphic depiction. The identification of individual candlestick signals creates great profitability from assembling candlestick signals into price patterns. The effectiveness of candlestick signals and patterns are the result of one basic premise. Investor sentiment reacts the same way during a specific area of a trend over and over. Mastering candlestick analysis results in being able to exploit price movements that are going to reoccur with a high degree of probability. Fortunately, mastering candlestick analysis is relatively easy. It is merely common sense investment practices put into a graphic depiction.

Producing profits from candlestick analysis is relatively easy. It is learning what to expect after the appearance of candlestick signals in specific areas of a trend. Witnessing a candlestick buy signal in oversold condition produces a high probability condition resulting in an uptrend. Conversely, witnessing a candlestick sell signal in overbought area creates a high probability that the sellers are starting to take control. Obviously there is some credence to these observations, otherwise we would not be looking at candlestick signals hundreds of years after they have been developed. If an investment method does not work, it is not going to stay around.

Understanding the investment psychology built into each individual signal allows for the identification of high probability/high profit candlestick patterns. The same conditions apply to candlestick patterns as they do to candlestick signals. There is going to be expected results that should occur a high percentage of the time. Knowing what the expected result should be permits a candlestick investor to participate in high profit moves. An added advantage becomes the ability to anticipate the next move after the anticipated result of one pattern going into the next pattern.

Steady price trends as witnessed in the first weeks of 2012 allow for price patterns to set up and perform. A predominant candlestick price pattern that produces strong profits is the Fry pan bottom. This pattern develops as a slow indecisive down trending move. It eventually has a slow flattening period, followed by a slow uptrend in price. The slow uptrend is the result of investor sentiment starting to build up confidence. Identifying a Fry pan bottom set up has major advantages. It allows an investor to anticipate when the exuberant buying will come back into the price movement. This usually occurs at the same level as when the pattern first started developing. Unlike looking for candlestick reversal buy signals in the oversold conditions, a Fry pan bottom breakout will usually occur when the conditions have moved back up into the overbought area. As can be seen in the VMED chart, a slow rounding Fry Pan bottom pattern produced the expected results, a strong bullish price move.


Chart 1

Knowing the conditions that signal a price break out, the candlestick investor has the opportunity to make big profits in a short period of time. However, the analysis does not end upon seeing sell signals at the top of the strong price move. Profits can be taken but the chart should still be maintained on the watch list. The next price pattern can be anticipated.

The J hook pattern!

The J hook pattern has a prerequisite: the initial element of a J hook pattern is a strong price move. This is what has been produced by a Fry pan bottom breakout. Upon witnessing and acting on the first sell signals after the strong uptrend keeps the chart on the watch list due to the anticipation of a J hook pattern setting up. The advantage created by individual candlestick signals allows for an accurate identification of a J hook pattern.

The J hook pattern is created after a strong price move, then selling comes into the trend. Candlestick investors have the advantage of identifying the type of selling that is occurring. Each of the major candlestick signals has specific characteristics. The Doji, the spinning top, the hammer, and the inverted hammer signals represent indecisiveness. After a day or two of pullback following a strong price move, if indecisive candlestick signals start to appear, it can be assumed there is not any great strength in the selling sentiment. After a few days of indecisive signals, if some bullish candlestick formations start to appear, slowly moving the price back up, it can be assumed the recent selling was merely profit-taking during an uptrend. This new bullish action now creates a J hook pattern set up. As with all candlestick patterns, there is now an expectation of what the next price trend will do. If wave one is a strong price move resulting from the Fry pan bottom breakout, wave two becomes the profit-taking area. Wave three becomes the next element of the J hook pattern. It will have an anticipated price move of at least the same magnitude as wave one.

Knowing the expectations of candlestick patterns produces a very powerful investment process. It dramatically reduces the emotions involved with investing. Knowing that price patterns occur due to the reoccurring phases of investor sentiment produces opportunities to take advantage of price movements with putting the probabilities in our own favor. Having expectations of what the next price move magnitude should be permits an investor to create investment strategies that maximize profit potential. This may include buying or selling calls or establishing bullish spreads. The probability of expected results occurring allows for calculated trade strategies versus emotional decision making.

An investor does not have to have extensive technical trading knowledge to utilize candlestick signals. The strongest aspect of candlestick analysis is its visual characteristics. Each signal and pattern has common sense investment criteria built into them. Where most investment program promotions try to sell investors on their newly found "secrets" for extracting profits from the markets, utilizing candlestick signals is completely the opposite. There are no secrets about candlestick analysis. Making large and consistent profits is merely learning how to use candlestick analysis correctly.

Happy Trading,

Stephen Bigalow

About the Author
Stephen W. Bigalow is author of Profitable Candlestick Investing, Pinpointing Market Turns to Maximize Profits, High Profit Candlestick Patterns and Candlestick Profits, Eliminating Emotions is also principal of the www.candlestickforum.com, the leading website provider of information and educational material about Japanese Candlestick investing on the internet. Over 28 years of extensive study and utilization of candlestick analysis has produced an array of easy-to-learn educational material about Candlesticks. As one of the leading Candlestick experts in the nation, Mr. Bigalow, through consulting with major trading firms, has developed multiple successful trading programs from the day-trader to the long-term hold investor.